Boards play a crucial role in shaping the direction of ESG in business. As part of their duties, they must oversee the suitability and performance of a company’s ESG strategy, with far-reaching consequences for how they operate and the capabilities they need for success.
ESG begins with purpose
Purpose implies companies have an objective beyond profit maximisation. This means they must identify and address the issues that are important to all their stakeholders—for example, customers, employees, governments, regulators and the media—and not just their shareholders.
For companies, ESG can be seen as the activity that underpins and delivers on their purpose. This includes actions related to environmental issues, such as climate change, social issues like labour practices, and governance matters such as executive pay.
But how do boards and management teams approach purpose and ESG in a tangible way? It helps to consider a Venn diagram with four circles representing all the risks that the business faces, all the risks that society faces, all the growth opportunities for the business, and all the hopes and wants of society. Purpose sits at the intersection of the four circles.
Management teams should lead this purpose-discovery exercise. In light of its outcome, they should perform a materiality analysis to identify the specific aspects of ESG most important to stakeholders. Boards must satisfy themselves that both the purpose-discovery exercise and ESG materiality analysis are appropriate and sound. All of this work is multi-stakeholder in scope, so boards are ideally placed to provide independent oversight and scrutiny based on their understanding of the needs of various constituents outside (and in) the company.
The board also needs to determine how it will oversee and monitor ESG efforts. It should assign detailed oversight to relevant committees. For example, the nominating and governance committee will oversee the company’s ESG story for investors, while the compensation committee will ensure ESG is effectively incentivised by executive compensation plans, and the audit committee will assure the adequacy of ESG disclosures.
Trouble ahead
Boards must contend with increasingly polarised and politicised public opinion and a growing backlash against ESG in some quarters. Stakeholders, including customers and employees, expect businesses to act and take a view on ESG issues. But they expect this view to reflect their own.
This is where boards must tread carefully. What they shouldn’t do is allow the views of CEOs and management teams to steer the outcome. Principal-agent conflicts arise when shareholders in public companies are asked to essentially underwrite a CEO’s particular take on values related to the E, S or G in ESG. Boards are well positioned to guard against this and push back if necessary.
To determine what to do and say about ESG, boards should instead rely on the purpose statement and materiality analysis. These assets have been created on the basis of a thorough understanding of stakeholder sentiment and a desire to balance the needs of various stakeholder groups.
Boards can help management by asking three key questions as a screening exercise to determine what and how to communicate on ESG issues: Does the topic align with the purpose statement and materiality analysis? Can the company speak with integrity about the topic? Is the company best placed to have an impact? If the answer to these questions is yes, boards should encourage management to act.
For example, a bank may decide to leverage its lending relationships to support the implementation of ESG. By incentivising corporate borrowers with reduced lending rates for achieving ESG-related targets, it can influence improvements in governance, working conditions, gender pay disparity and many other areas. Or a retailer may focus on supply chain sustainability by setting targets for itself and its suppliers related to packaging waste, carbon emissions or transport optimisation.
Steps a board can take
The risks and opportunities associated with ESG are not only financial, legal and regulatory in nature. They are also reputational as they relate to company brand, perception and growth. Therefore, boards should balance and integrate the perspectives of not only the finance, risk, compliance and legal functions, but also marketing and communications. For example, corporate communications can guide on relations with media, influencers and analysts. This is important as building credibility through third party endorsement is crucial for ESG success. Similarly, marketing can advise on customer sentiment and the communications approach and tone required for different customer segments and geographies.
Boards can perform an important role in validating strategic messaging. The overarching ESG narrative and communications plan must address the needs of all stakeholders. Boards should scrutinise the narrative to ensure it is coherent and consistent, but also suitable for each different stakeholder group. For example, investors will require disclosures in the proxy statement and updates to board committee charters, to reflect ESG oversight responsibilities; whereas customers and employees will expect content that explains how ESG helps them and the planet and what they can do to support it.
ESG implementation is largely a cultural process of changing hearts and minds and influencing action. Keeping stakeholders informed about progress and providing concrete examples is essential to gaining their support and realising the benefits of ESG. This is often best done by promoting awareness, engagement and education through sharing best practice, case studies and learning. Boards should ensure specific examples of progress are made available in support of strategic messaging.
ESG in the future
To successfully drive problem solving and decision making in ESG, boards need expertise in—and an emphasis on—stakeholder management and communications, in addition to traditional areas such as corporate strategy and financial management. With the right skills, experience and perspective, boards can help management teams develop and communicate their ESG agenda successfully.
ESG is reframing how we define and manage long-term value creation. It helps strengthen legal and regulatory compliance, licence to operate, brand and reputation, customer acquisition and retention, and financial growth. It enables companies to continuously improve their business proposition, manage the risks to themselves and society, and ultimately serve the market in an effective, responsible way.
Kamyar Naficy is the founder and principal of KNECTCOMMS